The EU And Japan Move Closer

Any news that emerged from last week's G-20 Summit in Hamburg, Germany was bound to be overshadowed by the high theater of the first-ever meeting between U.S. President Trump and Russian President Vladimir Putin. As a result, the biggest actual development from the Summit garnered very little attention in the American media. In fact, it did not involve America at all.

On July 6th, the European Union and Japan announced a broad EU-Japan Economic Partnership Agreement. The fact that the agreement was presented at the time when world attention was focused on the G-20 can be viewed as a snub to President Trump, who has routinely disparaged these types of comprehensive deals. It also placed added pressure on Prime Minister Theresa May in the Brexit negotiations, as it was clearly meant to demonstrate what the UK will be missing if it leaves the Union. Politics aside, the deal could have a major impact on corporate strategy and earnings within the EU and Japan with effects ranging far into the global economy.

Last year, according to World Bank statistics, the U.S. GDP was some $18.6 trillion, comprising still marginally under a quarter of the world's economy. In aggregate, the EU was second with a GDP of $16.4 trillion. Japan is ranked fourth with $4.9 trillion. As a result of the potential close cooperation it envisions, this deal would create an economic bloc that would be larger than the U.S. economy.

During the cold war, the U.S. used military and economic pressure to establish clear leadership on the world stage and to curtail the spread of communism. The economic end of those efforts unquestionably resulted in some trade deals that offered foreign countries access to lucrative American consumer markets and negatively impacted some American businesses. On the campaign trail, Donald Trump was able to whip up widespread resentment against these deals, like the Iranian Nuclear deal, the Trans-Pacific Partnership Agreement (TPPA), and even the North American Free Trade Agreement (NAFTA), which just a few years ago was considered a success by both Democrats and Republicans. Trump even managed to characterize NATO itself, somewhat accurately, as a version of a bad trade deal for the U.S. He argued that the de facto defense subsidies that American taxpayers provide to NATO (we pay more towards the NATO budget than all other members combined), sacrifices U.S. economic interests for the sake of political leadership of dubious value.

President Trump was elected, promising to correct these perceived imbalances. He pulled out of the TPP negotiations, and has made some noise about renegotiating NAFTA. In May, President Trump called for NATO members to pay their "fair share." The sharp change in tone from prior U.S. Presidents can probably be summed up best in German Chancellor Angela Merkel's much publicized statement during an election rally in Munich, saying "The times in which we could completely depend on others are, to a certain extent, over,...We Europeans truly have to take our fate into our own hands." This is the lens through which we must view the EU's decision to fast track its negotiation with Japan.

To be fair, the EU-Japan trade block is not one of the world largest. In fact, Japan is the EU's seventh most important trading partner, according to 2015 figures of the European Commission Directorate-General for Trade. Furthermore, EU-Japanese trade has been relatively in balance, according to Bloomberg. These facts would argue that a deal between the EU with Japan was not particularly pressing.

However, the EU and Japan share many interests and suffer from some of the same economic headwinds. For some time Japan and the EU both experienced frustratingly slow growth. Their new proposed agreement may stimulate the growth that both sides sorely lack. In essence, custom duties of some $1.1 billion a year will be eradicated according to the EU Commission. While some tariffs will remain, the agreement will make Japanese technical requirements clearer and thereby easier for EU businesses to understand. It will allow increased European exports of foodstuffs, pharmaceuticals and medical devices. Meanwhile, giant Japanese auto manufacturers, like Honda and Toyota, will be allowed to penetrate EU markets more easily. Companies in these industries should benefit, especially once a final agreement has been signed and ratified. If successful, the proposed agreement likely will lower certain prices in the EU and Japan and put pressure on U.S. manufacturing competitors.

Furthermore, the fact that the agreement will cover data protection may present certain American technology giants, which favor the free storage and movement of data, with considerable difficulties.

Finalization of the agreement will require further complex negotiations. For example, automobiles face both manufacturing and safety standards. But as self-driving capabilities become ever more important in the industry, manufacturers will face computer data standards, which are considered services rather than manufactured products, which can be far more complex to negotiate.

Regardless, the eventual agreement has to be ratified by all 27 EU governments remaining after Brexit. The Belgian Walloon objections to the recent EU-Canada trade agreement illustrated just how uncertain can be the path towards EU ratification.

It is likely also that by announcing the agreement so publicly while it was still under negotiation, the EU had in mind to issue a rebuke to Prime Minister May for daring to ask to leave the EU and to intimidate her to soften her negotiating stance. Even as the EU's second largest contributor, May appeared to be ostracized publicly at the G-20 meeting with her only friend being President Trump. My advice to May would be to ignore these unsubtle prods and to stay the course to negotiate a clean and unambiguous exit.

Trade deals are extremely complex and are vital to long-term national wealth creation and even economic survival. They require very tough negotiations but, if successful, they can prevent potential trade wars from escalating into hot wars. While President Trump is right to put America's interests first and to cast a highly skeptical eye on our existing trade agreements, we should be careful not to find ourselves isolated on the world stage and to play catch up as the rest of the world formulates increasingly complex technology and industrial policies.

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John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.